A Costco gasoline station is shown in Plano, Texas, Wednesday. Costco Wholesale Corp., which had been benefiting as consumers look for discounts, says earnings will miss Wall Street estimates because of weakness in its gasoline operations and tighter margins as it holds off on price increases to drive sales. - AP

Costco's sagging income reflects its freeze on prices

Costco Wholesale Corp. said Wednesday that its earnings for the current quarter will be lower than expected as it delays raising prices on items from food to patio sets amid soaring energy costs that have accelerated in recent weeks.

Shares in the nation's No. 1 warehouse club operator — which had been one of the few bright spots in retailing — plummeted almost 12 percent Wednesday. Rival BJ's Wholesale Club Inc. fell more than 10 percent as investors see Costco's willingness to hold prices on some products steady as a sign BJ's may have to do the same.

The reduced profit outlook from Costco reflects a dilemma that retailers, particularly low-price operators, face as the economy struggles: whether to raise prices on products — which could cost them customers — or resist price hikes from suppliers as long as possible, a move that depresses profits as they absorb higher costs.

Costco, which sells items in bulk and features gas stations at most locations, has attracted crowds of shoppers as they seek cheaper options. But Costco, like many retailers, can resist for only so long. Most ultimately are passing along the higher prices, which Costco officials said are being pushed by suppliers at a faster and higher rate in recent weeks than before.

That means more financial pain for shoppers.

"I think the consumer is just starting to see, not only with us, rising commodity costs and rising general merchandise costs in a much bigger way then they've seen other than with gasoline itself," said Richard Galanti, Costco's chief financial officer, during a conference call Wednesday.

At Costco, customers have seen the price for rotisserie chicken rise 20 percent in a matter of months and will face a 10 percent to 15 percent price hike on holiday decorations.

Soaring fuel costs are having a wide impact on Costco's business, including weakness in its gas operations. That's because Costco typically gets its gas deliveries on a daily basis — compared with traditional gas station operators who can get better deals since they buy in advance.

Higher energy costs are also affecting the freight costs of distributing merchandise, Galanti said. As a result, Costco now expect profits for the fourth quarter ending Aug. 31 to be "well below" Wall Street estimates. Analysts polled by Thomson Financial expected Costco to earn $1 per share for the fourth quarter.

In particular, Galanti noted that in the past six to eight weeks, suppliers both large and small are pushing price increases in the 5 percent to 10 percent range and even greater, compared to a 2 percent to 4 percent range in the first three quarters of the company's fiscal year.

"It's times like this, painful as it may be, that holding off on (price increases) on certain key items by even a few weeks, we believes helps strengthen our business for the longer term," he said. When Costco does pass along higher prices, it wants to be the last retailer to do so, Galanti said.

Galanti also said the company's reduced outlook reflected a greater-than-expected effect from its inventory method that assumes the most recent inventory purchases or goods manufactured are sold first. During times of rising prices, that results in a charge that eliminates inflationary profits from net income.

Soaring gas prices have also affected profitability at Costco because gas is a low-profit area, and it accounts for a bigger part of the business, according to Ken Perkins, president of RetailMetrics LLC, a research company in Swampscott, Mass. Costco reported a 9 percent gain in same-store sales for June, but excluding gas sales, that increase would have been 5 percent. Same-store sales are a key indicator of a retailer's health.

The company will report fourth-quarter and fiscal year results on Oct. 8.

Costco's shares fell almost 12 percent, or $8.57, to close at $63.43.

For a number of years, Costco sold rotisserie chickens — a staple item for its customers — for $4.99, but cost pressures forced the company to raise the prices to consumers to $5.49 about 12 weeks ago. Starting this past Monday, customers are now paying $5.99, though Costco says that for each price move it held off in passing along the higher costs to customers several weeks after the prices had been increased.

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